Public Bill Committee

[Mr. Jim Hood in the Chair]

(Except clauses 7, 8, 9, 11, 14, 16, 20 and 92)

Jimmy Hood: I welcome the hon. Member for Burnley to the Committee. Congratulations on your appointment.

Clause 30

Tax relief for business expenditure on cars and motor cycles

Question proposed, That the clause stand part of the Bill.

Kitty Ussher: Thank you very much, Mr. Hood. It is a real pleasure to be once again, if somewhat surprisingly, serving under your chairmanship in my third consecutive year on the Finance Bill. I have learnt one thing in the last 24 hours, which is that there are Finance Bill gods. It seems that they are slightly vengeful and playful gods, because roughly 24 hours ago I was, I confess, teasing one of my hon. Friends, who shall remain nameless, for saying that their entire life had, yet again, been taken over by the Finance Bill. I was glorying in the fact that, although I served on it in the last two years, I was not required to serve this year. So there are Finance Bill gods and they are vengefulonly one swift phone call later, I found myself here again. However, the pleasure is no less diminished for serving under your chairmanship, Mr. Hood.
I have risen to speak on clause 30, although there are no amendments to it, because it introduces schedule 11, and I thought it might be helpful to the Committee to have an explanation of what we are trying to achieve. We are comprehensively reforming the rules on tax relief for business expenditure on cars. There are two incentives for change. The first incentive is simplification, on which we have responded to lobbying from the industry. Secondly, we wish to ensure that the rules on tax relief for business expenditure on cars also help us to achieve our environmental objectives.
The current rules require capital expenditure on cars costing more than £12,000 to be accountable for in single asset poolsthat means one asset pool per car so that the writing-down allowances can be capped. Businesses that hire, rather than buy, cars costing more than £12,000 are also restricted in the amount of hire expenses that may be deducted from their profits. Businesses therefore need to track expenditure on those more expensive cars on an individual basis for the purposes of their tax computations, but for larger businesses, the number of such car pools can run into hundredsin some automotive sectors, thousands. Stakeholders consider that the rules are outdated and impose a disproportionate compliance burden, and we agree.
It is, however, important that any reform is consistent with our environmental objectives. Carbon dioxide is the most important greenhouse gas contributing to climate change, and road transport is one of its major producers. The reform aims to contribute towards our targeted reduction in CO2 emissions. Following extensive consultation, an outline of the reform was announced at Budget 2008; further detail was published in December 2008. The Government have considered stakeholders responses in designing a new regime that will not only reduce compliance costs, but help to meet the UKs targets for reduction in greenhouse gas emissions.
The generous 100 per cent. first year allowances for expenditure on cars with very low CO2 emissions are unchanged. They were made available for a further five years until 2013 in the Finance Act 2008. Consistent with that, under the new rules, the rate of writing down allowances that businesses can claim in respect of all cars will depend on the cars CO2 emissions. Expenditure on cars will generally be pooled in one of two plant and machinery pools. Where the cars emissions are 160 g/km or less, the expenditure will be allocated to the main capital allowances pool and will attract the same rate of 20 per cent. per annum of writing down allowances, as applies to most other plant and machinery. However, expenditure on cars with emissions above 160 g/km will be allocated to the special rate pool and attract a lower writing down allowance of 10 per cent. per annum. There will therefore be a clear incentive to buy a lower CO2-emitting car.
The rules restricting the deductions from profits that businesses may claim in respect of car hire costs are also being reformed to act as a disincentive to using high CO2emitting vehicles. For leases that commence after April 2009, there will be a restriction of allowable expenses only where the hired car has CO2 emissions exceeding 160 g/km. In addition, and as a simplification measure rather than an environmental one, the proposed rules ensure that only one lessee in a chain of leases for a car will be subject to the lease rental restrictions. Respondents have agreed that the reduction in the proportion of cars in a single asset capital allowance pool and the application of the lease rental restriction to a smaller population of leases will achieve a welcome reduction in compliance costs. As an additional simplification, motorcycles will no longer be treated as cars for capital allowances purposes. That change, too, has been welcomed by business.
We think that the move to a CO2 emissions basis for capital allowances will act as an additional fiscal measure to motivate business to redesign their car policies and actively select lower emitting cars. While the new rules deliver the reform that businesses pressed for, in order to ensure fairness, the provision introduces transitional rules to guarantee that there is no change to the treatment of cars owned before the date of introduction of the new rules. The old rules are being retained for those vehicles for five years.
As I said at the outset, these provisions have been the subject of considerable consultation and are broadly welcomed by stakeholders.

Question put and agreed to.

Clause 30 accordingly ordered to stand part of the Bill.

Schedule 11

Tax relief for business expenditure on cars and motor cycles

Mark Hoban: I beg to move amendment 19, in schedule 11, page 108, line 30, at end insert
2A In section 45D(4) for 110 insert 160.

Mark Hoban: Is it a pleasure to serve under your chairmanship again, Mr. Hood. May I congratulate the hon. Member for Burnley on her return to the Treasury team? There is potentially one more Finance Bill left in this Parliament. She might decide whether to put some odds on serving on that too, having done three so far. I should also like to congratulate, in her absence, the hon. Member for Wallasey (Angela Eagle) on her promotion. Clearly, the prospect of my hon. Friend the Member for Hammersmith and Fulham making another speech about white label cigarettes manufactured in eastern European states led to her to put in a transfer bid. I am sure she will enjoy her work in the Department for Work and Pensions.
Amendment 19 is very much a probing amendment. We want to understand why in schedule 11 the Government use a different definition for a car with low carbon emissions from that used in section 45D of the Capital Allowances Act 2001, which defines cars with low CO2 emissions as those falling below a CO2 emission threshold of 110 g/km, whereas the schedules threshold is 160g/km. The amendment would increase the threshold in section 45D(4) from 110g/km to 160g/km. We are not arguing that that is the right threshold, We simply want to understand why one rate is used in one area and a different rate is used in the schedule for exactly the same definition. We are concerned that it might lead to some confusion among advisers about the definition of a car with low carbon emissions. That is the purpose behind this probing amendment.

Kitty Ussher: The answer is quite simple. We have 100 per cent. capital allowance for cars with emissions at or below 110 g/km; then, we propose a 20 per cent. allowance for cars with emissions up to 160 g/km and a 10 per cent. allowance for cars with emissions in excess of that. The legal definition is extremely clear. The purpose of our legislation is to encourage companies to purchase cars that are progressively more environmentally friendly. If they want to go straight away for cars emitting 110 g/km or less, that is fantastic and they will reap a reward for doing so. We are trying to shift the bell curve all the way down to encourage the use of lower emitting vehicles.

Mark Hoban: This is a slightly unfair question to ask the Minister, given her recent arrival in the Treasury, but was any thought given to using a different term? That is where the confusion arises. The 2001 Act uses the term to describe a car with emissions of 110 g/km or less; the same term is used in the Bill in reference to a 160 g/km threshold. To give clarity to taxpayers and their advisers, it would have been sensible to use a slightly different definition in schedule 11 to avoid confusion in the future.

Kitty Ussher: I can safely say that, as far as I am aware, no consideration was given to that. I am sorry if the hon. Gentleman is confused, but we think the intention is clear.

Mark Hoban: As I said, the amendment is probing. It would have been better for clarity if the Government had come up with a different term, to prevent confusion and to ensure that taxpayers understand the Governments aim exactly. Given that the Government do not wish to move on this, however, I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Mark Hoban: I beg to move amendment 20, in schedule 11, page 109, line 32, at end insert
(5A) An order under subsection (5) may not be made until 2 years after this Act has passed and any subsequent change will be subject to a 2 year notice period..
The purpose of the amendment is straightforward. We want to ensure some certainty for taxpayers and that, where an amendment is made to the thresholds, businesses are given some notice, so that changes are not simply made overnight. We want to ensure that businesses can plan how to meet the downward trend of emissionsshifting the bell curve down, as the Minister described it earlier. The amendment introduces a two-year waiting period for any changes made under new section 104AA(5) of the Capital Allowances Act 2001, inserted by the schedule, so that businesses can properly prepare.

Kitty Ussher: In a sense, I accept the spirit behind the amendment. We try to give businesses as much notice as possible. We understand that is important and we have no plans not to do that. However, as I said in my remarks on clause 30, the proposals have been consulted on extensivelyindeed the first consultation took place more than three years ago, which is a longer period than the two years notice proposed in the amendment.
We accept that planning and certainty are important to business, but we do not accept that a statutory requirement to wait for two years and always give two years notice is necessary or always desirable. I can think of circumstances where, for example, our policy proves to be more effective than we expected, leaving us with a policy that has achieved its design, but which we are unable to ratchet further for environmental purposes because of a provision such as this in the Bill. At the same time, I do not want to send a signal that we intend to change the capital allowances system arbitrarily. We think it important to consult properly, and the Government benefit from that.
I assure the Committee that we have no secret plan to change anything and that we are always committed to good consultation. However, I do not think it right to tie the Governments handsI am sure that the hon. Gentleman would agreein case different external factors come into play, such that government and policy would be better served by not being tied down in that way. The Government recognise the need to give business time to plan for changes, so I ask the hon. Gentleman to withdraw the amendment.

Mark Hoban: I am grateful for the hon. Ladys assurance that there is no secret plan to make changes. It would not have been a secret if it had been announced in this Committeealthough, on the other hand, it might well have been, given the extent of reporting of events in Committee.
Although the Treasury has made some progress towards improving consultation before making announcements, it does not have a perfect record. There are clauses, such as clause 92, on which no consultation was undertaken before an announcement was made. I am sure that, in the new mood that seems to be suffusing the Government right from the very top in relation to consultation and discussionnot that we have not heard that beforethe Minister will ensure that, where there are changes, proper consultation is conducted. I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Question proposed, That the schedule be the Eleventh schedule to the Bill.

Mark Hoban: I have two questions to raise about schedule 11. They are detailed points that have been raised with us by the Low Incomes Tax Reform Group, which has done a good job of examining how the Bills provisions will affect vulnerable people.
The first question the group has drawn to my attention is whether an impact assessment has been undertaken for the schedule addressing the impact on people with disability. A feature of Her Majestys Revenue and Customs disability equality scheme is that there should always be an assessment of the impact on people with disability. The Low Incomes Tax Reform Groups point is that disabled drivers might need to purchase larger and generally less CO2-efficient vehicles to accommodate their needs. They are not only faced with a potentially higher cost for the vehicle itself, but might receive only the lower special capital allowance rate of 10 per cent. Given the costs that many people with disability face, the group is concerned that the low capital allowance rate would put them in a worse position than they are in now, so it has asked the Minister to consult on the issue to see whether an exemption could be made.
The groups second point relates to the change in treatment of exempt hire cars for disabled people. The previous regime allowed hire companies to claim the writing down allowance on the full cost of those cars, rather than on the limited £12,000. It was believed that the Government were going to provide a similar exemption by allowing cars hired to disabled people to qualify for the higher 20 per cent. rate of capital allowances, regardless of CO2 emissions, but a technical note produced last year suggests that the Government have reached an agreement with the main UK supplier of such cars to disabled people whereby they will defer an application under state aid rules and look at other initiatives to increase the availability of cars with lower emissions for leasing to disabled people. Although the intention might be to increase the availability of those lease cars to people with disability, the concern is that, in the short term, hire companies might face higher costs, taking into account the loss of tax relief, and that those costs will be passed on to people with disability.
My final comment relates to a definition in paragraph 22 of schedule 11, which, in proposed new section 268D(2) of the 2001 Act, sets out four criteria people can use to determine whether they qualify as disabled people in relation to hire cars. Those criteria are quite complex, and I was asked why they cannot be simplified to include someone who is a disabled badge holder, rather than seeking to assess whether someone is a disabled person by reference to several different allowances.

Peter Bone: It is a great pleasure to serve under your chairmanship, Mr. Hood, and I welcome the hon. Member for Burnley to her new ministerial role.
On the basic issue dealt with by the schedule, if I understand it correctly, there is a low emission rate of 100 per cent. capital allowance. I wonder if the Minister knows to what cars that rate applies and how many of those cars are actually bought. I also wonder if the change to a 10 per cent. allowance for cars with high emissions and 20 per cent. for those with lower emissions is revenue-neutral, given the abolition of the separate pool.
Of course, we are dealing with a timing difference. It is not a case of money being given away. Capital allowances are recouped when the vehicle is sold, so there is either the balancing charge or the balancing allowance. What I would have expected to see in the schedule, given the state of the car industry, is the Government bringing forward 100 per cent. relief for fleet cars to encourage the purchase of new vehicles. After all, it is only a timing difference. That change to 100 per cent. relief would encourage companies to spend money. At the end of the day, the Government would get their money back when the vehicle was sold. That change would be an incentive that would help car manufacturing in this country. I wonder why the Government rejected that approach.

Kitty Ussher: I will take the questions in the order in which they were put. Yes, there is an impact assessment that specifically considers the impact on disabled people. I am sure that the hon. Member for Fareham will have that impact assessment in his papers. Although the Finance Bill can achieve many things, the policy intention behind the measure was to simplify the arrangements and ensure that they are consistent with environmental objectives, not to widen the scope of the policy. We wanted to ensure that the provisions and exemptions that are available for disabled drivers are replicated in the new legislation. As he rightly said, and as we have made clear several times, it is our intention, subject to state aid rules, to ensure that the exemptions are carried over into the new system. That remains our intention. The timing has been agreed with all the players.
The hon. Gentleman then asked specifically why in paragraph 22 we do not simply use the qualification criterion of a person holding a disabled badge. The answer quite simply is that the power to award a badge is devolved to local authorities and we wanted to ensure that we had a comprehensible and tighter set of criteria, so that the system and the resources are properly targeted on those people who need our support.

Mark Hoban: On the point about the blue badge, does the hon. Lady accept the argument that the Low Incomes Tax Reform Group made that, as a consequence of these changes, high costs may be imposed on people with disability who need larger cars?

Kitty Ussher: I am not entirely sure that the evidence points towards that conclusion, although I think that the Low Incomes Tax Reform Group is an effective lobby group and I commend it on the work that it does. The market is sufficiently dynamic that there is a large number of models available to suit peoples needs, so I do not think that these measures will create an extra cadre of people who will face additional financial hurdles. We are just seeking to replicate the current criteria in a new system that is simpler and that has greater environmental incentives for those who are leasing and purchasing cars.
It is a pleasure to serve again on the same Committee as the hon. Member for Wellingborough. To his question whether the policy is revenue-neutral, the answer is no. The impact assessment shows that, assuming that there is no change in behaviour, which is the crucial point, the policy would yield revenue to the Treasury of £485 million over five years. That figure is broken down year by year in the impact assessment.
The hon. Gentleman then suggested that we could have used the policy to boost the automotive industry. In his previous ministerial incarnation, my hon. Friend the Economic Secretary has been extremely closely involved in measures designed to have that effect. We hope very much that the effect of the policy will be a change in behaviour, precisely because of the new financial incentives that we are putting in place that will cause large companies with large fleets in particular to purchase more environmentally efficient vehicles, and thus to avoid paying the revenue that would otherwise accrue to us. That will provide precisely the spur for the green technology and green automotive industry that we want.

Peter Bone: My point was more that we have missed an opportunity to have an incentive. Yes, there is the stick to encourage us to switch to more environmentally friendly cars, but we then get only the standard writing down allowance. If we extended the allowance to 100 per cent., more cars would be bought and that would be better for our manufacturing industry.

Kitty Ussher: We could use the policy simply to pass over cash to the manufacturing industry. The Government do that in various ways, but it is more appropriate to have a targeted policy that seeks simultaneously to simplify the system, which is what business wants, and to provide a spur for investment in environmentally efficient vehicles. There will also be a third effect, which is to boost the development of those vehicles. In a sense, therefore, the hon. Gentleman and I agree.

Question put and agreed to.

Schedule 11 accordingly agreed to.

Clause 31 ordered to stand part of the Bill.

Schedule 12

Reallocation of chargeable gain or loss within a group

Ian Pearson: I beg to move amendment 18, in schedule 12, page 128, line 5, at end insert
(1A) In determining for the purposes of subsection (1)(c) whether subsection (1) of section 171 would have applied, it is to be assumed that subsection (1A)(b) of that section read
(b) that, at the time of the disposal, company B is resident in the United Kingdom, or carrying on a trade in the United Kingdom through a permanent establishment there. .
It is a real pleasure to serve under your chairmanship, Mr. Hood. At the 2007 pre-Budget report the Chancellor launched three reviews involving the Treasury and Her Majestys Revenue and Customs working in partnership with business to evaluate how a range of tax legislation could be simplified. Clause 31 and schedule 12 deliver the first simplification measure from one strand of that project, which deals with the capital gains of groups of companies.
The corporation tax system allows limited offsetting of the capital losses of one company against the gains of another when calculating their taxable profits. In the Finance Act 2000 that procedure was liberalised, so that an asset could be deemed to have been transferred within the group before an onward sale. That saved the administrative burden and expense of making an actual intra-group transfer. However, those rules do not allow all gains and losses to be deemed as transferred within a group; they only apply to the sale of an asset to a third party. That means that the rules do not apply when a gain or loss results from the liquidation of a group company or when a loss arises on the making of a negligible value claim. Losses on assets that have been destroyed, or gains from insurance receipts in such a situation, are also outside the scope of this otherwise useful tax measure.
The CBI in particular highlighted in its recent Budget representations that those restrictions can be administratively burdensome. Schedule 12 provides groups of companies with a simpler procedure to offset chargeable gains with allowable losses by removing those restrictions. Rather than deeming assets to be transferred intra-group prior to a third-party sale, companies will be able to elect for a capital gain or loss to be reallocated to another group company that is within the charge to corporation tax.
Amendment 18 addresses one area in which we have received representations that, because of a technical defect in the schedule, the policy aim might not be achieved. The issue only affects groups that wish to transfer a gain or loss to a non-resident company in a group that trades in the UK through a permanent establishmenta branch or agency here. Since 2000, non-resident companies have been treated as part of the capital gains group. Tax-neutral transfers of assets can be made to a non-resident company if it has a permanent establishment in the UK and the assets are used for the business of that establishment. That rule ensures that the treatment applies only to those assets on which the non-resident company will be chargeable to corporation tax on gains made from their disposal. That same condition is imported into the rules in schedule 12, but we have received representations from the Law Society that the new rule needs to be adapted further to operate properly when a non-resident company is involved.
When an election is made to transfer a gain or loss from the disposal of an asset to a non-resident company, the schedule already has a rule to ensure that a gain or loss on the asset will be a chargeable gain or an allowable loss to the non-resident company. That applies even where the asset would not otherwise be a chargeable asset for the non-resident company. However, the representations that we have received point out that one condition to be satisfied before an election can be made is that the asset is used in the UK trade of the permanent establishment, which is unnecessary in this context. Amendment 18, therefore, adapts the rule about when companies can make an election, to remove any doubt that non-resident companies with UK permanent establishments can always fulfil the conditions. I am grateful for the Law Societys representation, which is one that the Government are happy to act on.
The changes made by the schedule sweep away some restrictions that have prevented the full matching of capital gains and losses within groups and simplify the complex rules that deal with group relationships. That is the kind of simplifying change that the CBI and other representative bodies have long sought. I commend the amendment to the Committee.

Amendment 18 agreed to.

Question proposed, That the schedule, as amended, be the Twelfth schedule to the Bill.

Mark Hoban: I have a couple of quick questions for the Minister about the schedule, which arise from representations made by outside bodies. The first is about capital gains and losses that arise as a consequence of the operation of foreign exchange matching rules. The Institute of Chartered Accountants has expressed the concern that these seem to fall outside the scope of the schedule. It believes that they should fall within it, as those gains and losses accrue as a result of the operation of statutory provisions. Can the Minister comment on that?
There is concern about the drafting of new sections 171A(5) and 179A(5) to the Taxation of Chargeable Gains Act 1992 inserted by schedule 12. We have received comments that they would totally negate an election. We would have thought that the correct result would be that they would negate an election to the extent that it took the total amount over the actual gain or loss. There would be a difficulty if there were two or more simultaneous elections that transferred parts of the same gain or loss to two or more different companies, so there would be a choice as to which election to negate, but where there is no choice, surely the election should be reduced rather then simply negated.

Ian Pearson: On the question of foreign exchange, the reference in the schedule to in respect of an asset will exclude chargeable gains or losses in respect of liabilities such as those arising from forex hedging from the provision. The treatment of such gains and losses within the Exchange Gains and Losses (Bringing into Account Gains or Losses) Regulations is already under consideration in the forex matching discussions that are ongoing between HMRC and business representatives, and we have talked to business representatives about this. We intend to address that point in the next round of forex matching changes later in the year. Proceeding in that way will ensure that the whole regime is considered, rather than that one item being taken out of context. The industry is satisfied with the approach that we are taking.
The hon. Gentlemans second question was on multiple elections. It is correct that where two or more elections are made simultaneously that specify more than the gain or loss, none of those elections has effect, as a result of the new wording of new section 179A(5). The main issue that the new subsection addresses is the possibility of simultaneous elections where a subsequent election is made in respect of the same gain or loss. HMRC expects that it will be very rare for a group to make such an oversight. On the rare occasions that an oversight may happen, it is right that the group is able to submit correct elections that specify where it wants the gain or loss to go, rather than be subject to a statutory rule that may not achieve the best result on a case-by-case basis.

Question put and agreed to.

Schedule 12, as amended, accordingly agreed to.

Clause 32 ordered to stand part of the Bill.

Schedule 13

Chargeable gains in stock lending: insolvency etc of borrower

Ian Pearson: I beg to move amendment 90, in schedule 13, page 131, line 28, after treated insert under subsection (5).

Jimmy Hood: With this it will be convenient to discuss Government amendment 91.

Ian Pearson: The new rules in schedule 13 provide that, to the extent that collateral is inadequate to replace all the lent securities lost in the event of a borrowers insolvency, the lender is treated as making a disposal but receiving no consideration so that, effectively, a capital loss arises. The borrower then has a debt to the lender for the remaining value of the securities at the time of the insolvency, but because of that insolvency the debt is likely to be bad. In certain circumstances, it is possible that, in addition to the capital loss provided for by the schedule, a life insurance companys profits might be reduced by the amount of that bad debt, which results from the interaction of special rules for computing the profits of life insurance companies and the rules relating to the debts of companies, which are known as the loan relationships rules. The schedule contains a provision that intends to stop a debt being classed as a loan relationship if it results from the insolvency of a stock borrower and an inadequacy of collateral to fully replace stock. The effect is to prevent an unintentional double allowance for life insurance companies as a capital loss and as a bad debt.
The provision in the Bill as drafted contains an error. The drafting provides a formula for arriving at the amount of the debt that is not to be treated as a loan relationship, but unfortunately the formula does not produce the correct result. The cross-references to the rest of the provision do not work as they should. Government amendments 90 and 91 correct that error. Government amendment 90 adds a cross-reference to clarify the effect of another part of the change made to the capital gains rules. Government amendment 91 replaces the incorrect formula for arriving at the debt in question with a reference to a description of that debt elsewhere in the new legislation. The amendments do not change the legislations intended effect; they merely correct a drafting error.

Amendment 90 agreed to.

Amendment made: 91, in schedule 13, page 131, leave out lines 30 to 34 and insert
The liability mentioned in subsection (7).(Ian Pearson.)

Schedule 13, as amended, agreed to.

Clause 33

FSCS payments representing interest

Question proposed, That the clause stand part of the Bill.

Mark Hoban: I have a quick question. I understand the clauses intentions; the Minister and I have discussed the Financial Services Compensation Scheme in other arenas on more occasions than I care to remember.
The clause centres on the tax treatment of interest and assumes that a depositor will get back their funds in full from the FSCS, which is the way in which the scheme has operated during the current financial crisis; in effect, the Government have issued an unlimited guarantee where the scheme has been called upon for retail depositors. However, the schemes rules, as outlined in the Financial Services Authoritys handbook, actually limit compensation to £50,000. If we return to a more stable financial climate and the £50,000 rule applies, a depositor with a deposit of £60,000 will only get £50,000 back, but will earn some interest on that money from the date that the scheme comes into force, in respect of their institution, and the date that the money is paid to the depositor. Will the interest they receive be treated as compensation, and therefore free of tax, or as interest and be taxable?

Ian Pearson: This clause deals with one aftermath of the default of a number of banks. Because of these bank failures the Financial Services Compensation Scheme has paid out more than £3 billion of compensation to bank customers. The hon. Gentleman is correct. We have discussed a number of the general principles surrounding this on many occasions. The compensation paid included not only the principal on the accounts but also a sum representing interest that the customers would have received had the bank not defaulted. The sum representing interest is the subject of this clause.
To ensure that customers are in the same position as they would have been in had the bank not defaulted, it is necessary to tax the sum representing interest as if it were interest for tax purposes. Without this clause the sum representing interest paid by the FSCS would not be taxed in the same way as interest paid by the banks is taxed. This would lead to unfairness between those customers of the defaulted bank whose accounts had been transferred to another bank or building society and those who receive FSCS compensation. The customers whose accounts were transferred would still be taxed on interest received from their new bank or building society but the customers receiving compensation from the FSCS would not be taxed on the sum relating to interest.
The FSCS has rightly calculated the compensation it has paid by taking into account whether or not the customer was a taxpayer. If they were, then it deducted from the amount equivalent to interest, a sum equivalent to income tax, just as tax is deducted from interest paid by the bank. Without this clause non-taxpayers will not be able to claim repayment of the amount deducted by the FSCS, and customers of the defaulted bank, who are liable to higher rate tax, cannot be charged that higher rate tax. That is why the clause is needed.
The hon. Member for Fareham asked whether, if an FSCS payment is less than the original capital, any part of that payment will be treated as interest. Whether the original capital has been repaid is an issue that falls outside the scope of the clause. The amount and nature of the compensation paid by the FSCS is a matter for the rules of the FSCS. He will be well aware of that.

Mark Hoban: The clause affects the tax treatment of payments made by the FSCS. While the amount of compensation is a matter for the FSCS, where the payment received by the depositor is less than the amount they originally deposited, is it possible to treat the interest payable as being effectively not subject to tax because they have lost so much money? Should not the interest be seen as a form of compensation rather than a receipt to be taxed?

Ian Pearson: Our aim in the clause is to put depositors back in the situation that they would have been in, had the bank not defaulted. There is obviously a technical definition of compensation and how it applies. It is right to say that when the FSCS pays interest it is taxable, just as interest is. We are simply trying to bring people back to the circumstances that they would have been in. It is for the FSCS to determine the rules of its own compensation scheme and whether there should be a £50,000 limit or a higher one, as the hon. Gentleman understands.

Question put and agreed to.

Clause 33 accordingly ordered to stand part of the Bill.

Clause 34

Corporation tax treatment of company distributions received

Question proposed, that the clause stand part of the Bill.

Stephen Timms: I add my welcome to you, Mr. Hood, as Chair of the Committees deliberations this morning.
Clauses 34 to 37 introduce a significant package that modernises corporate tax rules for foreign profits. It will make the UK a more attractive headquarters location for multinational businesses by enabling a groups worldwide profits to be repatriated to the UK without tax being charged and without need for complex double taxation relief calculations. It is a major change to a more territorial system of business taxation in which we are essentially concerned with applying tax to profits earned in the UK and not to profits earned overseas. The key element of the package offers generous dividend exemptions compared with competitor jurisdictions, available to all companies regardless of the level of shareholding.
The package comprises four linked parts with one in each of the four clauses: first, a broad exemption for company distribution; secondly, a reasonable restriction on our generous interest-relief rules in the UK; thirdly, consequential changes to the controlled foreign company rules, and fourthly, the replacement of the Treasury consent rules with a much simpler reporting requirement. These have all been subject to substantial widespread consultation which has shaped what is before the Committee.
I shall say a little more about each of the four elements. Clause 34 introduces schedule 14, which provides exemption from tax for foreign profits. It reduces administrative costs and it meets businesss call for exemption in the Finance Bill. The result of these rules is that the great majority of distributions for small, medium and large companies will be exempt from corporation tax. That change has been widely welcomed, as has the fact that we have been able to deliver it in this Bill.
Clause 35 introduces schedule 15, which prevents excessive advantage being taken of our interest-relief rules, particularly in the context of dividend exemption. This debt cap applies only where groups put more debt in the UK than they borrowed for their entire worldwide business. It is a reasonable restriction and will allow generous tax deductions for interest, notwithstanding the move to dividend exemption.
Clause 36 introduces schedule 16, which makes three consequential changes to the controlled foreign company rules. The first two relate to introduction of dividend exemption and remove some of the exemptions within the controlled foreign company regime, which will no longer be appropriate. Part 3 of the schedule includes a provision to ensure that the debt cap cannot interact with the controlled foreign company rules in a way as to cause double taxation.
Clause 37, introducing schedule 17, removes existing Treasury consent legislation and replaces it with a modernised, post-transaction reporting requirement targeted at transactions where there is a substantial risk of tax avoidance activity. The old rules have been replaced because they are out of date and are not in line with modern practice. The new requirement will apply to material transactions that pose significant risk of tax avoidance, reducing the administrative burden on business but ensuring that HMRC can focus on serious avoidance. We have also committed to examine the controlled foreign company rules in more detail separately. The review aims to modernise the current rules. It will be consistent with the move that I have described towards a more territorial approach of taxing foreign subsidiaries.
This package represents the outcome of nearly two years of extensive and constructive consultation. I want to thank all those who have contributed in the past couple of years. Businesses have consistently said to us that it is important for the UK to have dividend exemption. They have asked for it to be included in this Finance Bill rather than being delayed any further, to enhance the competitiveness of the UK tax system. I am very glad that we have been able to do that.

John Pugh: This is a very important part of the Bill, as the Minister has underlined; it is very technical but also very important. I want to congratulate him on having introduced this package of measures. It is a crucial package, as it is an attempt to show how a modern taxation system can cope with the global nature of modern commerce.
I want to start by being wholly positive, because I am afraid that I will have to be just a little bit critical later on. Schedule 14 immediately follows and I will make a few general remarks about it. It is definitional and loophole-closing; it is based on a study of real-time transactions, and it definitely has an eye on preventing further abuses of similar ilk.
The effectiveness of this type of legislation depends on the post-hoc scrutiny, the retrospective examination by people within the Treasury who must have adequate skills and abilities to do so. I am a little encouraged, not only by what the Minister has said but by the endeavours of HMRC to recruit appropriate people to police the type of activity that we are discussing on a more regular basis.
In one way, we are looking at a game of chess. On the companies side there are very clever people trying to make the best of the exemptions that are available and on the Governments side there are people trying to close every conceivable loophole. Life has been made enormously more difficult for those people who want to avoid tax by the Governments imposition of an obligation on businesses that insists that they must declare any tax schemes well in advance. However, the real test of the Bill is whether or not adequate ground rules are laid down to prevent further abuse and further misuse of tax exemptions. We will have to judge whether the Bill has passed that test when we look at the next clauses.

Mark Hoban: As the Financial Secretary said, the Government have undertaken quite a thorough consultation process on this issue in the past couple of years. As a consequence of that consultation process, there have been a number of changes of tack by the Government on the taxation of foreign profits. I just wanted to explore that issue a little further.
When the Government published their consultation in 2007, they produced a fair summary of the issue that we face when they said:
The current system of taxing foreign dividends and relieving double taxation through crediting foreign tax produces only a modest amount of direct tax yield, but together with the Controlled Foreign Companies (CFC) regime, provides safeguards to ensure that profits from economic activity are properly taxed in the UK.
It is a question of getting that balance right, which provides a link to some of the later thoughts that the Government had. The document went on to say:
The case for change rests largely on supporting large and medium business operating in rapidly growing global markets by simplifying and modernising the current regime.
The challenge that the Government had to face was that a number of multinationals were taking the view that the UK was not a good place for them to be based and they were exploring whether or not they could move to other jurisdictions where there was a better regime for the treatment of foreign dividends.
The consultation process also hit upon the issue of ensuring that profits from economic activity were properly taxed in the UK. That led the Government to consider the issue of a proposed controlled companies regime to avoid the potential mischief of companies seeking to shift income streams offshore, particularly what were described as mobile income streams, which are financing income and royalties. When the Government floated that idea, however, there was a significant outcry from industry about the consequences, certainly about the administrative cost, and it triggered a further wave of concern from companies that look to redomicile overseas. The further concern was about whether the rules that the clause seeks to change led to a sub-optimal allocation of capital in an international groupthat when it was not necessary for an overseas subsidiary to pay a dividend to its UK parent for the purpose of making a dividend, those dividends and that capital would be trapped in an offshore location. There was concern that the Governments rules got in the way of the efficient use of capital in businesses because businesses felt that it would be better to keep profits in a low-tax jurisdiction rather than repatriate them to the UK.
One of the issues that has most exercised the Government, and on which I would be grateful for further clarification from the Minister, is cost. Cost was a feature of the technical note published in July last year by the Ministers predecessor, the right hon. Member for Liverpool, Wavertree (Jane Kennedy), who expressed concern that the potential cost of the dividend exemption would act as a barrier to taking it forward. That technical note, published at the conclusion of our deliberations on the Finance Bill 2008, set out that in 2005-06 £200 million was collected in corporation tax paid on foreign dividends, £100 million was paid on portfolio dividends and £100 million was paid on direct dividends. The assessment was that by 2012 the yield on foreign dividends would be about £300 million. However, the technical note suggested that the tax loss to the Exchequer that could arise from introducing the dividend exemption had a central estimate of about £600 million, within a range of £200 million to £1.1 billion, depending on the behavioural responses. There was a suggestion that the tax take could increase because of the repatriation of cash to the UK, which would then be used to reduce indebtedness. The Government were sceptical that that was an issue, and felt that there were ways in which companies could repatriate those profits without incurring a corporation tax charge.
Cost was clearly a barrier at that point, but it no longer appears to be a barrier to the Governments changes. The impact assessment published after last years pre-Budget report suggested that the package of measures would cost about £275 million. That is a significant shift from the estimate that the Government produced in July last year, and I shall be grateful if the Minister can provide a breakdown of the figures, to explain the sources of revenue. I suspect that the cost of the dividend exemption remains broadly unchanged but that the changes the Minister referred to in his opening remarks to things such as the debt cap and Treasury consent may be yielding more income. It is important that there be greater clarity about how the Government were able produce a revised estimate that made the dividend exemption more affordable.
As I mentioned earlier, the proposals set out in 2007 looked at a move to an income-based regime, to ensure that businesses did not use the opportunity of the dividend exemption to restructure their operations and move various sources of income overseas for tax purposes, rather than as a consequence of how their businesses operated. That led to a significant outcry from businesses. Deloitte stated that
in our view, this could significantly detract from the UKs competitiveness, both from a financial and an administrative point of view, and could dissuade companies from locating holding companies here.
Ernst and Young commented on the potential compliance burden that would arise from that, stating that the proposals would
neither improve clarity and transparency, nor make the rules more certain and straightforward in applicationthey are in fact a significant move in the opposite direction.
The outcry prompted the Government to move, as there was a big concern that moving from an entity-based stream to an income-based stream would require businesses to rework the basis on which they submit information to the Treasury. Companies currently account on an entity basis and so would have to revisit how they structure their reporting to deal with it on an income basis. Clearly, the concern that businesses will seek to move certain income streams offshore to lower-tax jurisdictions still exists, as there might be a particular incentive in relation, for example, to intellectual property rights or to finance income. Is the Minister content that the anti-avoidance measures in schedule 14 are sufficient to tackle those issues relating to mobile income streams, or is that still a potential gap that will need to be addressed later?
Another point I want to raise relates to the structure of the exemption and the way in which it is given. Schedule 14 starts with the premise, as set out in proposed new section 930A, that all distributions received will be subject to tax. The existing legislation is framed differently: the assumption is that all distributions received in relation to UK shares are not taxed, but those in relation to overseas shares are taxed. We have now moved to a basis on which all dividends and distributions are taxed unless there is an exemption. Could the Minister explain why that change has been made? It has been suggested to me that, given the increased importance of the European Union in matters of direct taxation, because of issues relating to the freedom to establish and freedom of movement, that means it is difficult to distinguish the dividends and distributions of UK companies from those of non-UK companies.
Therefore, we have made the regime more challenging for UK companies than it was before, and I shall be grateful if the Minister can provide some clarification on that. Will that change, which we will debate in greater detail when we come to schedule 14, increase the compliance cost to UK business as a consequence? There is a concern about how the legislation has been structured, so it would be helpful if the Minister would explain why that move from a distinction between UK and non-UK distributions has been changed, because I think that that will have a knock-on effect, as we will debate later.
We are broadly content with the concept to which the Government have moved: that there should be a dividend exemption for foreign dividends. I think that that will help to address the issues of competitiveness that the UK faces as a location for holding companies. It has taken a long time to get thattwo yearsand at one stage last year I thought we might never see it. It is good that the exemption will make it on to the statute book, but an understanding of how the Governments objections on the grounds of cost have been overcome would be helpful.

Stephen Timms: I am grateful to both Opposition spokesmen for their support for the principle of what we are doing and the approach we have taken. Consultation has been broad, and as the hon. Member for Fareham pointed out, the proposals have been substantially modified in the light of our discussions. As we go through this part of the Bill there will be several technical discussions on the details, which will be important, but I am glad that the principle has been so strongly supported. The hon. Member for Southport was right to highlight the importance of our ability to continue to bear down on avoidance, and we will debate the issue later.
The hon. Member for Fareham asked about the costs involved. He is right to say that our initial intention was to make the change in a fiscally neutral way. As he indicated, there is a degree of uncertainty about precisely how companies will react to the changed framework introduced by the clause, so one cannot be too definitive about exactly what the fiscal impacts will be. However, as discussions have developed and as we have listened to the concerns that have been raised, we have relaxed the requirement that the change should be fiscally neutral. Consequently, while the initial intention was for the package to be revenue-neutral, it now has a cost.
On next years expectation, dividend exemption will lead to a tax reduction of £500 million and we expect that to be offset by £200 million from the impact of the debt cap, which we will discuss in relation to the changes to the controlled foreign companies rules in clause 36. We also expect a loss of revenue of £50 million as a result of the abolition of the Treasury consents rule. All of those changes mean that we expect an overall loss of revenue of £150 million, which will grow as time goes by and companies increasingly reorganise their activities in the light of the changes.
The big difference is that, whereas we initially envisaged the debt cap as centring on a companys net debt, it now centres on gross debt. That is the big change both in the structure of our proposals and in the fiscal impact.

Mark Hoban: The right hon. Gentleman says he expects the cost of the package to increase over time. I assume that there will be a tax loss as companies restructure their activities and repatriate profits. Does he anticipate that businesses will also look at the way in which they structure their financing to reduce the additional tax, or will they pay the consequence of the introduction of the debt cap?

Stephen Timms: I am not sure whether the hon. Gentleman is thinking about a particular kind of change, but I am certain that, with a substantial change of this kind, companies will want to look at potential opportunities for them to change the way in which they organise themselves in order to take advantage of the provision. That is perfectly appropriate. He was right to raise concerns about potential avoidance opportunities and we will debate a general anti-avoidance rule later in relation to a Government amendment. We certainly need to keep a close eye on avoidance activity, but in response to an earlier question of his, I believe that the measures under consideration will do the job.
The hon. Gentleman asked why some UK to UK dividends will be taxed for the first time. We need to provide equality of treatment for UK and non-UK dividends, as the previous inequality was not appropriate. In fact, the impact of the proposals on UK dividends will be pretty minor. We need to be certain that there is no risk of a challenge under EU law, because challenges of that kind lead to damaging uncertainty that is in nobodys interest. The legislations structure gives us a helpful guarantee on that front.

Question put and agreed to.

Clause 34 accordingly ordered to stand part of the Bill.

Schedule 14

Corporation tax treatment of company distributions

Mark Hoban: I beg to move amendment 43, in schedule 14, page 133, line 15, after nature, insert
other than in the case of a distribution within the meaning of section 209(2) of ICTA..

Jimmy Hood: With this it will be convenient to discuss the following: Government amendments 92, 93 and 99.
Amendment 48, in schedule 14, page 140, line 36, leave out is in and insert
was in the accounting period ending immediately before.
Government amendments 101 and 102.

Mark Hoban: I shall speak to amendment 43 first. This touches on a point I raised in the clause stand part debate about the treatment of UK to UK dividends. Under existing rules all distributions from UK companies are non-taxable, but new section 930A presumes that they are taxable unless they are exempt. The Minister acknowledged that it was the threat of challenge under EU rules that gave rise to that equality of treatment between UK and non-UK distributions. That is a topic that I will come back to under the next clause as well.
Having established that all distributions are taxable, there is then a series of exemptions from that tax. If an exemption is met, no tax is payable on those dividends. That is very straightforward. Where the problem arises is that in some cases there is a difference in treatment between distributions and dividends. The titles of the five exempt classes demonstrate that. There are three related distributions, which relate to controlled companies, non-redeemable ordinary shares and portfolio holdings, but also limited dividends from transactions not designed to reduce tax and dividends in respect of shares accounted for as liabilities.
The issue stems from the exclusion, in new section 930A(2), of a distribution of a capital nature. The feedback I have received is that the principles for that exclusion are relatively untested. To determine whether a distribution is of a capital nature, they would have to be tested against some very unclear case law. There are certainly some cases where distributions that were previously exempt will no longer be so under the new provisions and that will increase uncertainty in some fairly common transactions. Amendment 43 says that all distributions currently falling under section 209 of the Income and Corporation Taxes Act 1988 should continue to be exempt, so that there is a continuity of treatment between the old regime and the current regime.
Amendment 48, which I have also tabled in this group, deals with a small companies exemption. Schedule 14 provides for two regimes: one for small companies and one for medium and large companies. Schedule 14 provides a definition of a small company in new section 930R. However, it creates a degree of uncertainty as to whether a small company is a small company in the year of the dividend accounting period. My amendment seeks to create some certainty by referring back to the accounts of the previous accounting period to determine whether a small company is a small company. Rather than the uncertainty of new section 930R inserted by the schedule, which looks at the current accounting period, amendment 48 refers to the previous accounting period to give the taxpayer greater certainty.

Stephen Timms: Schedule 14 provides the new exemption, which we have been discussing, from corporation tax for dividends and other distributions from foreign companies. It amends the rules on taxation of distributions received from UK companies. The exemption will remove the need for groups to make complex double tax relief calculations and will allow profits to be repatriated, even in circumstances in which there would not have been enough double tax relief to eliminate a UK tax liability. Until now, when there was insufficient credit for foreign tax, overseas profits would typically stay offshore, with cash possibly being returned in the form of an upstream loan. Alternatively, groups might have adopted complicated, artificial ways of repatriating such profits other than through a dividend. Exemption will sweep all that away and allow for immediate repatriation of profits and the return of cash by dividend. That will enhance the attractiveness of the UK as a location for the headquarters of multinational businesses.
The rules will apply to distributions received by all companies in the UK, including small companies, which was not part of the original proposal. The rules for small companies are distinct from the rules for medium and large companies, but, in each case, the vast majority of all dividends and other distributions will benefit from the exemption. That protection, alongside that contained in clause 40 and schedule 19, which deal with personal dividend taxation, are a proportionate response to the risk of abuse of the exemption by small companiesthe protection set out in the schedule. However, we will keep a close eye on the matter and take immediate action if any avoidance activity is identified.
The hon. Member for Fareham moved amendment 43 on capital distribution. Schedule 14 applies only to distributions of an income nature. The amendment would increase its scope so that it applied to most capital distributions as well. However, schedule 14 is concerned only with the taxation of distributions that represent income. Nothing in the schedule will cause any capital distribution that is currently exempt to become taxable, so there is no reason to extend the scope of the exemption as suggested. The legislation does nothing to alter the taxation of capital distributions that are excluded from the scope of proposed new part 9A of the Corporation Tax Act 2009. There is already an exemption for capital distributions, known as the substantial shareholdings exemption. It is not part of this Bill to change in any way the scope of that exemption, so I hope that he will accept that the amendment is not appropriate.
As the hon. Gentleman explained, amendment 48 would alter the definition of a small company. However, in doing so, it would change the standard definition used to determine whether exemption follows the small company rules or the rules applicable to larger companies. The legislation uses the standard European Commission definition of a small company, which includes a time lag whereby a company that changes from small to medium sized retains the status of small in the transition year but becomes a medium company the following year. A similar rule applies if a company moves down in size from medium to small. The amendment would delay the change of status by a further full year. That would be an additional complication and make it less likely that the appropriate legislation for that size of company was applied. I hope the hon. Gentleman will accept that that is an unhelpful additional complication.
Several Government amendments in this group are concerned with a rule that denies exemption if a foreign tax deduction is given for the distribution, on the basis that a distribution that is tax deductible represents a deduction from taxable profits rather than distribution of those profits. Therefore, it is closer to an interest receipt than a distribution and would be expected to give rise to a taxable receipt for the recipient. The rule denying exemption is extended to cases where amounts determined by reference to a distribution are tax deductible. That ensures that the rule cannot be side-stepped by the use of indirect tax deductions obtained through avoidance schemes. The change will also enable some simplification of the manufactured dividend rules, which no longer require a specific exception. I therefore recommend that Government amendments 92, 93, 99,101 and 102 to schedule 14 be accepted. I hope that the hon. Gentleman will not press amendments 43 and 48.

Mark Hoban: I am grateful to the Minister for his comments, particularly on amendment 48 and the transitional year which dealt with the issue that I was seeking to tease out. I have a residual concern about amendment 43. My understanding is that certain distributions that would have been untaxed under the existing rules, because of the UK to UK rules, are taxable now. I will go back and think carefully about whether any issues ought to be drawn to the Ministers attention and be the subject of further debate on Report. I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Amendments made: 92, in schedule 14, page 134, line 1, leave out
any amount determined by reference to.
93, in schedule 14, page 135, line 17, leave out
any amount determined by reference to.(Mr. Timms.)

Mark Hoban: I beg to move amendment 44, in schedule 14, page 135, line 32, leave out subsection 6(c) and (d) and insert
the words is resident in the United Kingdom and after person who in each of paragraphs (c) and (d) of subsection (6).

Jimmy Hood: With this it will be convenient to discuss the following: amendment 45, in schedule 14, page 135, line 36, leave out from of to end of line 38 and insert an ordinary share..
Amendment 170, in schedule 14, page 136, line 19, after dividend, insert or other distribution.
Amendment 49, in schedule 14, page 141, leave out lines 29 to 34.

Mark Hoban: The amendments cover several issues. Amendment 44 deals with the exemptions in proposed new section 930EDistributions from controlled companies. I am concerned that in introducing this measure the Government have omitted some of the existing tests for controlled companies. It refers to holdings which, for a variety of reasons, may be split between various groups of companies but in aggregate mean that the company has control.
The existing tests read:
(c) if the person is resident in the United Kingdom, rights and powers of any person who is resident in the United Kingdom and connected with the person; and
(d) if the person is resident in the United Kingdom, rights and powers which for the purposes of subsection (5) above would be attributed to a person who is resident in the United Kingdom and connected with the person (a UK connected person) if the UK connected person were himself the person.
The situation here is that the ownership of subsidiaries may be split so that neither of the owners have control within the basic provisions of controlled foreign companies legislation, but taken together they would have control. If we do not replicate this in subsections 6(c) and (d), those dividends would fall outside the exemption and would therefore be taxable. It is not clear why the change has taken place. The explanatory notes suggest that the definitions replicate the CFC rules, but this exclusion for indirect ownerships suggests that that is not the case. The amendments try to address that by enabling shareholdings held through non-resident affiliates to be aggregated together.
Amendment 49 refers to the issue of redeemable shares. In the UK ordinary shares are assumed not to be redeemable. One concern is that the law in other jurisdictions is not as clear as in the UK, so there would be a risk that a distribution might be taxable when it should not be. My amendments seek to clarify that point and I would be grateful for the Ministers comments. If there is an issue about people using redeemable ordinary shares, is it not better to tackle it through an anti-avoidance route rather than the provisions in proposed new section 930F?
Amendment 170 is a drafting amendment that seeks alignment: subsection (1) of proposed new section 930H refers to a dividend only, whereas subsection (1) of proposed new section 930G refers to a dividend or other distribution. Assuming that there is no reason for this difference, the amendment would simply correct a drafting error.

John Pugh: I wish to speak against amendment 44. I understand that it replaces reference to Income and Corporation Taxes Act 1988 provisions with the words,
is resident in the United Kingdom
and person who. This is undesirable because the vagueness of UK residency requirements can lead to individuals exploiting distributions from controlled foreign companies and achieving tax advantages. The legislation is best left as it stands. I understand that there are difficulties at the moment in equating certain well-known Tory donors residency with their tax situation, and bringing residency into this is unsatisfactory.

Stephen Timms: Chapter 3 of the schedule introduces a set of exempt classes, and the amendments in this group, as we have heard, all act to increase the scope of the exempt classes in various ways. The idea of the exempt classes is to give exemption in circumstances where the risk of avoidance is low. The benefit is that the anti-avoidance rules can be targeted at narrow situations rather than being of general application. That is a significant benefit and I am cautious about extending exempt classes because of the risk of losing some of that benefit.
Amendment 44 would increase the scope of the exempt class for controlled companies in a way that would allow a distribution to fall within an exempt class even if the payer of the distribution was not within the scope of the CFC legislation. That exempt class gives exemption to more than 90 per cent. of dividends by value. It takes a simple and direct route to exemption for controlled companies, which is possible because the CFC rules protect against artificial diversion of profits. The protection reduces the risk that this exempt class might be abused by avoidance schemes and allows it to be free of any other conditions for exemption.
The effect of the amendment would be to allow the rights and powers of a connected foreign company to be taken into account in determining whether the payer of a distribution is a controlled company. Therefore, a distribution paid by a company controlled outside the UKand therefore outside the scope of CFC defencescould be brought within this exempt class, so there is a potential danger of an unacceptable fiscal risk. The attribution was limited to UK companies, and that brought the risk of another EU legal challenge. The extension of that to all companies would have brought unacceptable risks and hence we removed it altogether.

Mark Hoban: Is the Minister certain that a significant risk is attached? I understand that the rules were in place under the existing regime. They allowed non-UK affiliates to be taken into account in determining whether the basic control rules were met. We seem to have shifted away from that. I am concerned that the Minister is taking a potential threat and using it in support of the changes, rather than recognising that the rules currently permit that aggregation to assess whether control has been in place. He has not justified as robustly as we would expect why we should move away from that position.

Stephen Timms: What I understand the hon. Gentleman to be asking is whether there is a real risk of EU challenge from the arrangement as it was. We have been very careful throughout the exercise to ensure that we are absolutely secure from any challenge under EU law, because such a challenge would create uncertainty which would be in nobodys interest. I am not aware of anyone proposing to mount a challenge, but the way in which we have arranged this now means that we can be absolutely certain that there will not be a challenge. That is an important bolstering of the confidence with which people will be able to operate once the arrangements are in place, and is a worthwhile protection against challenge.
Amendments 45 and 49 would remove one of the two conditions required for exemption in the second class, which applies to distributions paid on non-redeemable ordinary shares. This class is relevant where the first class is unavailable because the CFC rules do not apply. An ordinary share is one that carries no preferential rights. The reason for the restriction is that in the absence of CFC defences, preferential rights attached to shares may be used to allow distribution exemption to be used to convert what would otherwise be taxable profits into exempt dividends. We need that when ordinary shares are not redeemable, since the right to redeem share capital might otherwise be used to provide an alternative form of preference for the shareholders, and we think that that would represent an unacceptable fiscal risk.
I should remind the Committee that a dividend that does not fall into the exempt class can still qualify for exemption. A dividend will always be exempt if it is not derived from transactions designed to reduce UK tax. That is the effect of the later part of chapter 3. The exempt class provides a simple route to exemption for many dividends, but it is not the only routethere is also a fall-back. I suggest that the amendments are not necessary and would create a significant avoidance risk.
Finally, turning to amendment 170, I should say again that there is a fall-back exempt class that ensures that dividends paid in wholly commercial circumstances are always exempt. The exempt class is based on a test of the profits out of which a dividend is paid. Exemption is given, provided that the profits do not derive from transactions designed to reduce UK tax. A dividend is necessarily paid out of profits, but the same cannot be said for other types of distribution. Since the class is a test of profits and not directly a test of the distribution, it is limited to dividends.
I am satisfied that amendment 170 is not necessary to enable all commercially derived profits to be repatriated in a tax-free form, which is our aim. The extension to non-dividend distribution would create risks because of the lack of a necessary link between the distribution and the profits. I hope that on that basis the hon. Gentleman feels able to withdraw the amendment.

Mark Hoban: The areas that we are seeking to legislate on are obviously complex. The Financial Secretary has said that there are fall-backs that would allow distributions to be exempt in particular circumstances. It would have been helpful, where possible, to have drawn together on that. I do not understand why he objects to amendment 170; if a distribution is not designed to reduce tax, why is that not part of the clause? There is a danger that the dividing line that the Minister is seeking to draw between what should and should not be exempt will become quite complex.
The Financial Secretary is yet to give a robust explanation for why it is not appropriate, in relation to amendment 44 for example, to repeat the foreign affiliates rules in the existing CFC legislation, but we will not dwell on that. Part of the challenge with schedules 14 and 15 is that they have been heavily amended in the past few days, and I think that people need more time to think through some of the consequences. I am sure that that will be one of the themes that will emerge in later consideration. We are in danger of giving outside bodies insufficient time to think about the consequences of those changes and the knock-on effects. Having said that, I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Stephen Timms: I beg to move amendment 94, in schedule 14, page 136, line 30, leave out apart from and insert otherwise than by virtue of.

Jimmy Hood: With this it will be convenient to discuss the following: Government amendments 95 to 98.
Amendment 46, in schedule 14, page 139, line 43, leave out dividend and insert distribution.
Amendment 47, in schedule 14, page 140, line 2, leave out dividend and insert distribution.
Amendment 51, in schedule 14, page 147, line 30, leave out expenditure and insert territory.
Government amendments 103 and 104.
Amendment 59, in schedule 15, page 172, line 33, leave out Part and insert Schedule.
Government amendment 100.
Amendment 50, in schedule 14, page 143, line 20, leave out paragraph 9 and insert
9 In section 806J, after subsection (7) insert
(8) Sections 806A to 806K shall not apply to any distribution paid after 1 July 2009 other than a distribution in respect of which an election has been made under section 930Q of CTA 2009..

Stephen Timms: This is a mixed group of Opposition and Government amendments, all of which address relatively minor drafting points. I have so far resisted amendments from Opposition Members, but I am pleased to say that on this occasion I will be urging my hon. Friends to support the amendments tabled by the hon. Member for Fareham, which I am happy to accept. [Interruption.]

Jimmy Hood: Order. Calm down.

Stephen Timms: I was rather hoping that we might have had a little oratory from the hon. Member for Fareham in support of the amendments, but even without the oratory I am happy to accept them and hope that the Committee will accept the Government amendments as well.

Mark Hoban: Well, I am almost overwhelmed to the point of speechlessness by the acceptance of the amendments. I just wish that they were of a more substantive nature, as that would have shown that the time of change had come after all. They correct drafting errors where the Government have inappropriately used the word dividend instead of distribution. Proposed new section 930P refers to distributions in the context of diversion of trade income, but the drafting refers intermittently to dividends and distributions, and we have already discussed circumstances in which either dividends or distributions might be appropriate.
Amendment 51 corrects a different typo: the line should have referred to territory, but currently refers to expenditure. The amendments are fairly straightforward. I wish I could claim authorship, but someone more eagle-eyed than me identified the issues. I am grateful to the Minister for accepting them.

Amendment 94 agreed to.

Amendments made: 95, in schedule 14, page 136, line 33, leave out from beginning to is in line 34 and insert Any other dividend.
96, in schedule 14, page 137, line 14, leave out apart from and insert otherwise than by virtue of.
97, in schedule 14, page 137, line 17, leave out from beginning to is in line 18 and insert Any other dividend.
98, in schedule 14, page 138, line 18, leave out from that to end of line 20 and insert
does not fall into an exempt class by virtue of section 930E but would, apart from this section, fall into an exempt class otherwise than by virtue of that section..
99, in schedule 14, page 138, line 46, at end insert
930MA Schemes involving distributions for which deductions are given
(1) This section applies to a dividend or other distribution that would, apart from this section, fall into an exempt class.
(2) The distribution does not fall into an exempt class if
(a) the distribution is made as part of a tax advantage scheme, and
(b) the following condition is met.
(3) The condition is that a deduction is allowed to a resident of any territory outside the United Kingdom under the law of that territory in respect of an amount determined by reference to the distribution..(Mr. Timms.)

Amendments made: 46, in schedule 14, page 139, line 43, leave out dividend and insert distribution.
47, in schedule 14, page 140, line 2, leave out dividend and insert distribution.(Mr. Hoban.)

Stephen Timms: I beg to move amendment 100, in schedule 14, page 143, line 9, leave out sub-paragraphs (2) and (3) and insert
() In subsection (3) (as it has effect as amended by paragraph 8 of Schedule 30 to FA 2000)
(a) before paragraph (a), insert
(za) if the dividend is received in an accounting period of the recipient in which the recipient is not a small company, and the dividend is a relevant dividend, the profits in respect of which the dividend is paid;,
(b) in paragraph (a), at the beginning, insert in a case not falling under paragraph (za),, and
(c) in paragraph (c), at the beginning, insert in a case not falling under paragraph (za),.
() After subsection (3) insert
(3A) For the purposes of subsection (3)
(a) small company has the same meaning as in Part 9A of CTA 2009 (company distributions),
(b) relevant dividend means a dividend that, for the purposes of section 930H of that Act (dividends derived from transactions not designed to reduce tax), is treated as paid in respect of profits other than relevant profits (see subsection (4) of that section), and
(c) the profits in respect of which a dividend is paid are the profits in respect of which the dividend is treated as paid for the purposes of that section..

Jimmy Hood: With this it will be convenient to discuss amendment 50, in schedule 14, page 143, line 20, leave out paragraph 9 and insert
9 In section 806J, after subsection (7) insert
(8) Sections 806A to 806K shall not apply to any distribution paid after 1 July 2009 other than a distribution in respect of which an election has been made under section 930Q of CTA 2009..

Stephen Timms: Amendments 50 and 100 centre on the way in which double taxation relief is given in the rare cases in which a dividend is taxable. Government amendment 100 deals with the interaction between the rules in part 9A that apply to taxable dividends and the double taxation relief rules. If a dividend is paid out of profits that have been subject to foreign tax, the double taxation relief rules allow the foreign tax to be given as a credit against the UK tax due on the dividend to ensure that the same income is not taxed twice. The rules currently allow a large amount of choice in the specification of the profits out of which the dividend is paid, which is important because the foreign tax paid on the specified profits determines the amount of foreign tax credit available. The distribution exemption schedule includes an anti-avoidance rule that considers the source of the profits out of which a dividend is paid. If those profits result from transactions designed to reduce UK tax, the dividend will be taxable in the UK.
Since the Bill was published, it has been brought to our attention that there is a risk that avoidance schemes might exploit the mismatch between how profits are specified for the purpose of the anti-avoidance rule and how they are specified for the purpose of double tax relief rules. The amendment therefore overrules the usual choice available in the double tax relief rules. It will ensure that, where a dividend is taxable in the UK because it is paid out of the profits of tax avoidance, double tax relief available on that dividend will be calculated by reference to those same profits. The amendment will remove a significant risk of tax avoidance exploiting a mismatch whereby a dividend intended to be taxed would escape any effective taxation.
Perhaps if the hon. Member for Fareham speaks to amendment 50, I will be able to respond later.

Mark Hoban: Amendment 50 deals with new section 930Q, which allows a company to make an election that a particular distribution that would otherwise be exempt should instead be taxable. The explanatory notes state that the two reasons why a company might wish to make such an exemption are that
dividends can only be taken into account for the purposes of the CFC acceptable distribution policy (ADP) exemption if they are subject to tax
and
it is possible that exemption could lead to an increased rate of withholding tax.
Paragraph 9 of schedule 14 amends the Income and Corporation Taxes Act 1988 to delete the onshore pooling rules and the rules that allow for relief in relation to eligible unrelieved foreign tax. The provisions are an integral part of the credit system of taxation and it is appropriate that they should no longer apply to dividends following the introduction of the exemption regime; there is logic in that.
However, a taxpayer may elect for dividends to fall outside the exemption regime. Therefore, a corporate taxpayer may elect for a dividend to be taxable in the UK if it is paid by a company resident in a territory with which the UK has a double tax treaty. The provisions that reduce or eliminate foreign withholding tax apply only if the dividend is subject to tax in the UKthe sort of scheme where one might want to have a taxable rather than an exempt dividend. The expectation is that where people take advantage of that election, they should also be able to take advantage of the existing rules on onshore pooling and the use of eligible unrelieved foreign tax. Amendment 50 would enable people who take the election under new section 930Q to take advantage of the rules on onshore pooling and the use of unrelieved foreign tax.

Stephen Timms: A principal purpose of the legislation is to simplify the process of paying dividends to the UK. Amendment 50 would retain a significant body of complicated legislation on onshore pooling rules. I hope that I can persuade the hon. Gentleman that it would do so with little, or possibly no, benefit. It would retain the onshore pooling rules solely for the benefit of those dividends that a company elects to be taxable. Why would a company do that? The two most likely reasons are to obtain lower rates of foreign withholding tax and, during a transitional period, to allow dividends to qualify for the ADP exemption from controlled foreign company legislation, which we will come to later.
Although the onshore pooling rules can apply to withholding tax, by far their main application is in connection with underlying tax. It is rare that dividends that qualify for underlying tax credit also suffer withholding tax, because intra-group dividends are generally exempt from such taxes. ADP dividends are in all cases excluded from onshore pooling. It is not justified to retain onshore pooling and the significant amount of legislation on that for that very limited purpose. The rules were introduced in 2001 to balance the introduction of the so-called mixer cap. That need has been removed by dividend exemption, so the rationale for the onshore pooling rules will end as well. I hope that the hon. Gentleman feels that he can withdraw his amendment.

Mark Hoban: The Minister has given a satisfactory explanation and his point about the change to the mixer cap arrangements suggests that the onshore pooling arrangements are no longer necessary. Although I have not moved amendment 50, when the time comes I will not press it to a Division.

Amendment agreed to.

Amendments made: 101, in schedule 14, page 144, line 24, leave out from beginning to modification in line 32 and insert modification.
(3B) The.
Amendment 102, in schedule 14, page 145, line 36, leave out from following to modification in line 44 and insert modification.
(4B) The.(Mr. Timms.)

Amendment made: 51, in schedule 14, page 147, line 30, leave out expenditure and insert territory. (Mr. Hoban.)

Amendments made: 103, in schedule 14, page 148, line 28, leave out apart from and insert
otherwise than by virtue of.
Amendment 104, in schedule 14, page 148, line 37, leave out apart from and insert
otherwise than by virtue of.(Mr. Timms.)

Question proposed, That the schedule, as amended, be the Fourteenth schedule to the Bill.

Mark Hoban: I want clarification on some of the technical aspects of the schedule that we have not touched on. The schedule comes into effect on 1 July 2009, which is slightly odd. It will be difficult to do given that the Bill will not receive Royal Assent until after that date, but that is how we are making tax policy. There have been concerns about the impact of that date. Does the commencement date make it more difficult for foreign companies to meet the acceptable distribution policy?
The proposed changes to the Corporation Tax Act 2009 mean that from 1 July 2009, dividends can only be specified as being paid from the profits of the current period. When no profits are specified, the dividend will be treated as having been paid from the profits of the last period for which accounts were drawn up. That suggests that it be difficult for companies to qualify for the acceptable distribution exemption. In addition, a company accounting period that straddles 1 July 2009 will be, as a whole, under the controlled foreign companies rules. That may end up with CFCs trying to run other exemptions to get their dividends through.
PricewaterhouseCoopers suggested that a straddled period should be treated as split only in cases when a company pursues an acceptable distribution policy in respect of the first period, or for which an exempt activity holding company is claimed in the first period but not thereafter. Will the Minister clarify how the commencement date impacts on companies seeking to use the existing rules?
There is a disconnect between the sourcing rules in part 2 and other rules on the treatment of dividends. Are the rules consistent with the acceptable distribution policy? Will the Minister comment on the taxation of foreign permanent establishments, which has not yet been fully addressed? Where are the Government in that process?

Stephen Timms: We have had a helpful discussion on the schedule and the amendments. The new exemption from corporation tax for dividends and other distributions received from foreign companies which is introduced by the schedule is a key element of the package to enhance the attractiveness of the UK as a location for multinational businesses. As the hon. Gentleman said, it takes effect from 1 July 2009.
I say in passing that we have thought very carefully about the implementation dates of the various parts of the package. Therefore, as we will discuss shortly, we are introducing the debt cap for an accounting period which will begin on or after 1 January 2010, so that businesses have time to prepare. That the measure is being introduced later than the dividend exemption has been widely welcomed.
The hon. Gentleman asked about transitional arrangements. Any profits accrued in a foreign subsidiary before the package comes into force can be paid out as an ADP dividend and remain subject to the current rules, which may be a helpful clarification.
Considering the tax treatment of branches would have raised more issues and diverted attention away from the main point, which is the taxation of foreign dividends. We will bear branches in mind when we look at future options for controlled foreign companies, but we will not consider the treatment of foreign branches in detail until after the consideration and reform of the CFC rules.
I have one further point to make about the interaction with the ADP exemption. Amendment 100 removes the restriction on double taxation relief. Amendment to the CFC changes in schedule 16, which we will come to, will allow the split period to also be treated as split for the purpose of double taxation relief. There was indeed a problem in the area highlighted by the hon. Gentleman when the Bill was initially drafted, but I think that that has been solved by the various changes that we will debate today.

Question put and agreed to.

Schedule 14, as amended, accordingly agreed to.

Clause 35

Tax treatment of financing costs and income

Question proposed, That the clause stand part of the Bill.

Mark Hoban: This is an important clause. A number of issues have emerged since it was tabled, including the number of Government amendments to it. The extensive nature of the new rules on anti-avoidance and financial services groups is also important and needs to be addressed. However, I want to say something more broadly about the debt cap, because it is has given rise to some concern about what sort of behaviour it will incentivise. Is it the best way to tackle the issue that concerns the Government? Are we at risk of introducing a cumbersome process that will add to the compliance cost of business? Let me talk through some of those issues.
As the Minister indicated in the debate on clause 34 stand part, some of the cost of the dividend exemption has been offset by the introduction of the debt cap. That leads to interesting issues as to whether those reforms are linked, in the sense that if clause 34 is introduced, does clause 35 have to be introduced, or are the reforms taking place in parallel, with one raising revenue and one leading to a loss of revenue just a matter of convenience rather than a matter of planning how the tax structure will work? Clearly, when the debate about the taxation of foreign profits started in 2007, the Government had other ideas about how to tackle some of the behavioural challenges that arose from it. It was only when the original ideas on the control of companies ran into a degree of flak that they then moved on to the debt cap.
The aim of the worldwide debt cap is to target situations in which a UK group bears more debt than is required to finance the worldwide group. In addition, the measure could provide an effective means of targeting many upstream loans to the UK that are used to repatriate overseas cash. However, in order to protect those groups that are temporarily cash rich, the Government intend to allow the worldwide debt cap measure to be set aside where the group is in a short-term cash-rich position. Of course, that stems from the point that has been quite widely debated over several years that the UK has a very generous regime for interest expenseit is fully deductible. It is one of the issues that has perhaps led to an increase in leverage among a number of companies over the course of recent years and has certainly led to concern about whether it has incentivised a particular type of behaviour.
Although the Government flagged up last year that that is what they wanted to do, there is still concern about the workability of the proposals. Deloitte said:
Unfortunately the provisions remain very complex and represent a major compliance burden for groups even if they will have no ultimate disallowance of interest.
Adding 32 pages of tax codes could make the risk overly burdensome. The Institute of Chartered Accountants believes this matter could have been addressed in other ways:
We believe that the same policy objectives, which are to prevent the dumping of debt into the UK part of worldwide operations and the penalisation of upstream loans to the UK, could equally well be achieved by tightening up the existing thin capitalisation regime and introducing targeted rules against upstream loans.
Could other policy routes have been used to tackle unnecessary upstreaming that would not have added to the compliance burden on businesses? In the brief stand part debate, the Minister referred to the different commencement date for the debt cap arrangements. Will the gap between commencement dates be used for further consultation and to explore the alternative solutions, or are the Government determined to take this route?
Since the original proposals were published in draft last year, there has been movement by the Government and some of the complexity has been ironed out. However, UK-only groups will still be caught by the measure and will have to go through some compliance steps, which is regrettable. The proposals are meant to deal with debt that is incurred outside the UK by international groups, yet it appears from the drafting that UK companies will have to pay unnecessary additional taxes.
The debt cap places restrictions on the relief given to UK companies that form part of a worldwide group relating to the interest and finance expenses on transactions with related companies. The extent of that restriction on the intra-group interest and finance costs will depend on the external financing costs of the worldwide group. The Chartered Institute of Taxation questions why those restrictions are required, saying that
It is not clear to us why these provisions are required at all in addition to the many existing rules which are intended to restrict interest relief in certain situations, including transfer pricing, arbitrage provisions and
provisions of the Finance Act 1996. Both CIOT and ICAEW have concerns about the Governments approach.
The Minister suggested that the proposal was a move towards a more territorial system of taxation, and he is right: it is only a move towards that. It has not been fully articulated as the end point. Will he clarify whether we should move to a territorial system of taxation and whether the proposal is a staging post along that route or the end of such movement? If it is a staging post, what does he think the next moves should be?
There is a more fundamental concern about the impact of the measures on businesses. I have talked about compliance costs and about whether there are other ways to tackle the concern about loading UK-based companies with high levels of debt. There have been a number of comments from business and outside advisers about how the proposal will affect the way in which companies are structured and financed.
The Law Society has suggested that the proposals might encourage UK groups to incur more debt; encourage multinationals to transfer assets out of the UK; discourage inward investment into the UK; put over-leveraged companies at an advantage over cash-rich companies in making acquisitions in the UK; and discourage outward investment. I shall illustrate just one of those points, as it is quite important to reflect on the potential outcome. We could have a situation in which a UK-based company is being targeted by two potential acquirers. One could be an overseas company that is cash rich, but it would seek to finance its acquisition of the company through intra-group loans. Alternatively, there could be a highly-leveraged private equity situation, where there is quite a high level of external debt. Again, the company in that situation would use debt to finance the acquisition of the original UK-based company.
The concern that has been expressed to me is that, because the overseas parent company is cash rich, it has low levels of external debt or, as in this case, no external debt. The restriction on debt interestthe worldwide debt capwould kick in on that company. By contrast, if the UK company was acquired by a highly-leveraged private equity fund that had external debt, the fund would be able to use debt; it would not face the restriction on the deductibility of interest that the cash-rich non-UK company would face. As a consequence, it could borrow more to fund that acquisition; it could pay a higher price to acquire that other company.
Given that one of the concerns expressed recently has been about over-leverage in the markets, we seem to have a situation here whereby the proposed measures could encourage more leverage, rather than encourage companies to have significant cash resources, whether those resources are acquired through the retention of profits or through arranging money via share issues. The behavioural issues are causing some concern to outside bodies, and this could be an opportunity for the Minister to explain the Treasurys view.
As I understand itI am sure the Minister will correct me if I am wrongwe are the only country that has introduced a worldwide debt cap. Other jurisdictions have considered introducing some cap on tax deductibility debt within their own jurisdiction, but not outside it. Deloitte suggests:
The introduction of the debt cap cannot be regarded as a move which will enhance and support UK competitiveness and this aspect of the policy design of the debt cap seems more likely to damage the UKs competitive position than to enhance it.
Is the Minister prepared to comment on that assessment?
The second issue that I want to touch on relates to the compliance cost. I alluded to the fact that purely UK groups would also have to go through the process of calculating what their external financing is, even though they do not have any non-UK business. As I understand it, the problem is the gateway test that has been used. When the measures were originally consulted on, it was suggested that there would be a number of gateway tests, one of which would enable a purely UK group to avoid going through that process of calculating external finance. Will the Minister explain why there is to be only one gateway test?
The Chartered Institute of Taxation suggests that the reason why there is only one gateway test is our old friend, EU law, which we discussed in relation to the last schedule. It was said that EU law aims to ensure that the arrangements are waterproof and free of the possibility of legal challenge, which would mean that we will end up putting an additional burden on UK-only groups that should not really apply, given the nature of the debt cap rules. I should be grateful if the Minister explained why we have only one gateway test.
Three themes run through the general commentary on the measure. First, is it the best way to tackle the issue of the upstreaming of loans into the UK? Secondly, is the compliance cost too great? That partly links back to the fact that there is only one gateway test, which means that UK-only groups are caught by the measure. Thirdlythe problem that exercises a number of peoplethe measure could perversely lead to companies taking on more external debt, but would be to the detriment of inbound investment into the UK and perhaps outbound investment, too.

Mark Field: I echo the words of my hon. Friend in introducing the subject. I ask the Minister for an indication of the Treasurys broader thinking. No one can dispute that it is quite acceptable at times to utilise the tax system to incentivise or disincentivise certain behaviours. However, my concern is that the worldwide debt cap that has been put in place in the whole regime, rather short-sightedly, simply reacts to the specific economic problems of today, instead of looking at the long-term future.
We have a Finance Bill every year and I suppose that it is quite legitimate for any Government on a short-term basis to put such a regime in place to deal with the problems of the day, which can then be done away with in a year or twos time, but the proposed regime obviously adds an extra layer of complexity, not least because the worldwide debt cap applies to global companiescompanies with significant interests here in the UK, but which also have operations overseas. Given that it is a worldwide debt cap, I would be interested to have some indication from the Treasury as to precisely what negotiations have taken place with other countries and whether the measure is part and parcel of a concerted international process.
I worry that the measure may have been put in place because of the present problems. I accept that the genesis may not lie in September 2008, but may be found a little bit before that. That raises the obvious question that my hon. Friend mentioned in relation to the private equity industry. In many ways, we have seen a skewing of the tax system over the past decade or so: extremely low tax rates have made the putting of debt on to the balance sheet a much more attractive proposition. We are moving away from that now, and the Minister will rightly point out that, in the present climate, he wants to disincentivise having a hell of a lot of debt on the balance sheet. That may be an academic point, because I suspect that many private equity providers will not be able to get that much debt on their balance sheet, even if they want to. Many private equity players have problems, but because of the lack of liquidity they are trying to raise relatively small sums of money for debt-for-equity swaps. That is probably a more desirable way to run those businesses in the longer term.
Above all, I am keen to know what the Treasurys broad thinking is. Is this a short-term measure given our specific problems at the moment, or is it part of a longer-term regime to incentivise longer-term behaviours in relation to debt?

John Pugh: I rise to be constructive about clause 35 and the schedule that follows. It seems to be about the understanding of complex companies and their financial footprint. That is highly desirable. It ensures that profits are appropriately taxed and placed. It ensures that parent companies are identified. It is not always easy to find the parent company of a subsidiary. It is also mindful of the need to avoid double taxation. It is an exceptionally difficult area. The difficulty is well illustrated by the number of Treasury amendments that have appeared since the legislation was put before us. It also seems to me to be about an area on which most of us cannot directly comment. It is highly technical. Schedule 15 refers to things such as staple companies and stranded deficits. It also incorporates a fair amount of algebra, which other Members may be able to explain, but I certainly cannot.
It is also fundamentally about imposing international accountancy standards fairly rigorously, which I welcome. That is a recipe for business efficiency. People talk about tax efficiency as though it is the same as business efficiency, but when companies such as Amazon export things to Jersey in order to import them back into the country, one realises that the pursuit of tax efficiency can be quite different from efficient business practice.
The arguments and concerns with clause 35 are ones that we will hear in connection with any clause of this nature. People always talk about compliance benefits and capital flow. Those arguments are used so often that it is almost like crying wolf. One wants to know whether there is any credibility attached to the complaints here. It seems that some of the more vocal people voicing these concerns are those who are prepared to pay huge sums of money on tax advisers. Surely that could go some way towards meeting the clients costs.

Stephen Timms: In the previous clause we discussed the dividend exemptionthe cornerstone of this packageand the benefits to business of its introduction. The dividend exemption will come at a cost of tax forgone and could also lead to multinational groups taking undue advantage of those generous UK interest relief rules referred to by the hon. Member for Fareham. Clause 35 in schedule 15 introduces a limited restriction on the deductibility of interest in computing taxable profits.

Mark Hoban: Will the Minister explain a little further the link that he perceives between the dividend exemption rules and this particular clause? If this is about a group trying to transfer money into the UK, it could now make a distribution or pay a dividend that was tax free. How does he think that that is going to lead to greater use of upstreaming of loans into the UK?

Stephen Timms: I will respond directly to the point and argue that these two measures do indeed belong together. I will explain why in a moment and will also answer the hon. Member for Cities of London and Westminster. We are introducing a clear and fair principle to be applied to the treatment of interest for UK tax purposes. The UK is prepared to allow finance expense in calculating the UK profits of a group up to the amount of the groups entire worldwide external finance cost. That is a very generous rule by international standards, but it does prevent groups putting more debt into the UK than they have borrowed externally for their worldwide business. I want to be sure that the Committee has grasped that fundamental point. We are saying that companies will not be permitted under this arrangement to put more debt into the UK than they have actually borrowed across the whole world in gross terms. It is clear that that is a pretty generous constraint compared to others that we might have applied.
How and why does that measure belong with the dividend exemption? There are a couple of points on that. First, as we discussed earlier, there is a revenue gain from the debt cap to offset from the revenue loss resulting from dividend exemption; but dividend exemption would also open up potentially large avoidance opportunities, and the debt cap provides the limitation in a principled and relatively straightforward way to address that. It is certainly a simple idea in principle: a company should not charge in the UK more debt than it has across the whole world. The conclusion that we drew from the consultation over the past couple of years is that it is the most straightforward in practice as well as in principle. I do not claim that the measure has no complexity or that it is absolutely obvious how it applies in every case, but it is more straightforward than the alternatives.
The hon. Member for Cities of London and Westminster raised an interesting point. I do not see this as a short-term measure. It is certainly not part of our fiscal consolidation, for example, if that is what he was suggesting. It addresses a general problem of companies putting too much debt into the UK, which could become more prevalent once dividend exemption applies. So, the two measures belong logically together, and not just from the point of view of the measure providing some additional revenue that will be forgone as a result of dividend exemption.

Mark Hoban: I am still at a loss as to exactly where the link is between the two. I understand completely why the increased revenue that will come from the worldwide debt cap is there, and why it could be used to offset the losses that arise from the dividend exemption. However, the Minister is yet to demonstrate the linkage. What mischief will be created by introducing a dividend exemption policy that could be made worse by the tax deductibility of interest in the UK? The Minister has asserted strongly that there is a link, but has not given an example of a transaction that could sufferhe might have one in his hands as we speak. It would help to know exactly how he sees the two things linked, other than simply through offsetting losses and gains of tax.

Stephen Timms: What we have generally seen in the current regime is that companies use upstream loans to offset their tax liability on foreign dividends. With dividends to the UK exempt from UK tax, there is no case for allowing interest relief for loans to the UK because dividends can be paid instead. The two things belong together: dividend exemption could lead to business reorganisations that take advantage of both dividend exemption and the generous UK interest relief rules. We need to have measures in place to prevent that.

Mark Hoban: Will the Minister tell the Committee what proportion of intra-group loans upstream of the UK is there to tackle the issue of the tax payable on dividends in the existing regime, and what proportion is there for normal financing arrangements, for when an acquisition has been funded for example? A more factual basis for the Ministers argument would help if we are to be convinced that there is a real reason why the two measures are linked, other than simply to offset revenue.

Stephen Timms: I do not have those figures. From the point of view of HMRC, it is not always clearthere is no particular reason why it should bewhy a company is doing a particular thing. What is certainly true is that a large amount of tax that would otherwise, under the current regime, be payable on foreign dividends is offset by the effect of upstream loans. I perfectly accept the point that there are other reasons for having those loans, but it is a substantial feature of multinational taxation currently that upstream loans offset what would otherwise be tax paid on dividends.

John Howell: Will the Minister give way?

Stephen Timms: Let me just respond to some of the other questions that the hon. Member for Fareham raised, and then I shall gladly give way to his hon. Friend.
The hon. Member for Fareham and a number of other people have made the point that perhaps we could have achieved the constraint that we need in other ways. It is true that there are alternative approaches that can be adopted to address what you might call debt dumping, but each would imply compliance burdens on business. Before deciding that the debt cap was the right answer, we looked at other possible approaches and found that each of them presented its own challenges, and we concluded that the debt cap was the best way to proceed. Other countries adopt other approaches, and the hon. Member for Fareham has made the point that the UK is the first country to adopt an arrangement of this kind, which is probably true. However, if we look at the way such matters are handled in the US, our arrangement is much more straightforward and its attractiveness may well become apparent to other jurisdictions.
The hon. Gentleman asked whether the gap in the commencement date between 1 July and 1 January would be used for further consultation. After much consultation, we believe that the rules being introduced are appropriate. It is, of course, true that we can use the period between now and 1 January to listen to any remaining concerns, although I think that all the material issues have been addressed. If there are any other issues, people have the opportunity to raise them.

Peter Bone: Will the Minister give way?

Stephen Timms: Let me pause in answering the questions asked by the hon. Member for Fareham. I will first give way to the hon. Member for Henley before giving way to the hon. Member for Wellingborough.

John Howell: I thank the Minister for his generosity in giving way. He has said that it is not always possible to ascertain why companies do something, yet there is a test in the provisions to decide whether a loan has been taken out for a genuine commercial purpose. What are the parameters of the test? The complexity of the issue has also been raised. We have seen it go through a number of iterations in draft legislation, and it is quite clear that we are still on a journey. Will he tell us more about how that journey will be concluded? Clearly, a lot of things in the provisions are still inadequate.

Stephen Timms: I do not agree with the hon. Gentleman at all. There certainly was concern at one stage with our proposals. We discussed those concerns extensively and, in the discussions in which I have been involved, there has been a general welcome for the progress that has been made, and an acceptance that we now have a solution. Indeed, on Second Reading, the shadow Chief Secretary generously paid tribute to the consultation that had taken place and the conclusions that we reached as a result of it.
So I certainly do not agree with the hon. Member for Henley that the relevant clauses, together with our amendments today, leave us with legislation that is not readyit most certainly is ready. My only point is that there will be a pause between Royal Assent for the legislation and the debt cap taking effect. It is open to people to raise concerns if they have any, but I underline very strongly that I think that we now have the answer that we need.

John Howell: Will the Minister give way?

Peter Bone: Will the Minister give way?

Stephen Timms: I will give way to the hon. Member for Henley again before giving way to the hon. Member for Wellingborough, just so we do not lose our train of thought.

John Howell: My point picked up on the comment made by the Chartered Institution of Taxation that, without the full picture, it is difficult to comment on whether we think that the whole package will work. CIOT clearly does not think that it has the full picture.

Stephen Timms: Well, in terms of dividend exemption and the debt cap, it does. As I have repeatedly made clear, we want to complete the review of the CFC rules, which is an important next step. In response to the hon. Gentlemans question about our journey towards a territorial system of taxation, that review will be the next step in that direction. On the narrow topics with which the four clauses under discussion deal, the full picture is complete and in good shape.

Peter Bone: I am very grateful

The Chairman adjourned the Committee without Question put (Standing Order No. 88).

Adjourned till this day at half-past Four oclock.